As you may have seen recently during the 917 commercials interspersed with a few moments of football (my attention span just can't sit through that many commercials anymore!), Schwab finally just cut their trade commissions to zero. E-Trade quickly followed, along with TD Ameritrade, and Fidelity rolled out their zero expense ration mutual funds.
This prompted a few requests for JAM VIEWS to delve deeper into uncovering why real people, you and I, over the long-term never make the rates of returns advertized in the latest Wall street book, or espoused by Jim in Receivables who always lies about his 401k performance.
First, realize that trading commissions only make up about 7-12% of these institutions' top line revenue, so we don't need to fret over their future success. After running a Broker-Dealer (B/D) and Registered Investment Advisor (RIA) for two decades, I can tell you that the company makes money in twenty different ways aside from the client commissions. But, this week let's focus on why these commission prices are just one of the shiny objects which distract us from achieving long-term wealth. A quick list of more fundamentals below:
1. INDEX FUNDS VS. ACTIVE FUNDS? Bottom line is that it doesn't matter. Index funds buy or track a fixed basket of stocks or other investments, while active funds are daily operated by a manager or team of managers who make specific decisions on what to buy or sell. Generally, active funds will charge a .5% to 1% higher expense ratio because there are actual managers. Recently, for an extended period, index funds have outperformed active funds, so the marketers and the media now promote this as a historical truism. This is usually the point when the cycle reverses, as this one will also. They always do. Joel Greenblatt of Gotham Asset Management, a very successful hedge and mutual fund advisor, states, "Warren Buffet says most people should index, and I agree with him. But Warren Buffet doesn't index, and neither do I." The answer for us is to buy both. Buy the index funds which are appropriate for your long-term goals, and buy high-quality, experienced managers who have weathered many different cycles.
2. BUY STOCKS, BONDS, MUTUAL FUNDS, HEDGE FUNDS, EFTs, INDEXES, FUTURES, OR COMMODITIES? Bottom line is that we should buy a little bit of everything. In our investment firm, we preached thirteen (13) slices of the pie as a minimal blend to smooth out a client's performance chart, so they didn't hurt themselves (covered later). The simple key is to own a big basket of different investments which are aligned with your mission, yet which likely perform well (and poorly) at different times. In your Statistics 101 Course they labeled things that moved in tandem as having a correlation of 1.0, and things that moved opposite of each other as having a correlation of -1.0. You want your basket to, as closely as possible, have a correlation of 0.00. You want some things to be "zigging" while others are "zagging." Again, for most of us the answer is to access all of these categories through mutual funds, ETFs or Indexes, since we don't have the money, expertise or time to buy all of the individual stocks or bonds.
3. BUY GROWTH OR VALUE, LARGE-MID-SMALL CAP, CORPORATE OR GOVERNMENT BONDS, DOMESTIC OR INTERNATIONAL? Bottom line here is to invest in each style and sector. You, or the smartest managers and computers, will never predict what is going to be the hot spot next year. As in #2, take a little slice of each, and you will be light-years ahead of your neighbors. Remember, just when every singe advisor on CNBC and CNN says that Value Investing is dead, these funds will begin to outperform growth funds.
4. AMAZON'S LAST MILE? Have you followed how even mighty Amazon has struggled with the most efficient and effective logistics answer to get those Tory Burch shoes to your front door step? They offered employees to buy truck routes, are testing automated trucks, and of course those drones. Investing has the same problem. All of the above strategies, plus a million more, never work for us real humans, because we are human.
The television commercials and the ads in Forbes, Fortune and the Wall Street Journal are simply marketing strategies to gather dollars, trillions of dollars. They never help real people master Behavioral Economics. If you want to build wealth long-term, you must understand this. Everyone, and I mean everyone, buys high and sells low, especially Jim in Receivables - he just won't show you the real truth. Warren Buffet for many decades averaged 21% a year, double the average of the stock market, by simply buying good investments at fair values and holding them forever.
Joel Greenblatt again states, "When people can check their returns 30 times a minute on the internet, time horizons shrink, investors are impatient and sell at any sign of underperformance." The truth is that Jim in Receivables always does much worse than Susan in Shipping who never checked her 401k until a week before retirement.
Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the economic decisions of individuals and institutions. Economist Richard Thaler was awarded the Nobel Memorial Prize in Economic Sciences of "establishing that people are predictably irrational in ways that defy economic theory." Robert Shiller, winner of the 2013 Nobel Prize in economics, claims "the central issue in behavioral finance is explaining why market participants make irrational systematic errors contrary to the assumptions of rational market participants."
I know it sounds complicated, a lot to understand, but as with so many other topics we dissect in JAM VIEWS, successful long-term investing is much simpler than the world makes it out to be. Schwab's zero fees marketing is BS. Vanguard's 40-year war claiming .5% less fees were the Holy Grail didn't' make one real person one more dollar. More importantly, in October 1987, in 2000, and in 2008 Vanguard's .5% less fee didn't stop one American citizen from selling out their 401k after the market dropped 50%, and didn't ensure they were fully invested when the markets recovered up another 100%.
Don't be distracted by the shiny objects. Do opposite of what feels good. Understand that these cycles many times last for years. Just as I try to always talk you into first doing your own taxes, first understand the long-term investing basics. Then, if you want some help and oversight, get yourself a partner who doesn't follow the noise.
Have a great week!
ps. Did you see that CNBC hedge fund guru, Jim Cramer, has now joined Bull Market Fantasy to provide "expert opinion and advice on Fantasy Football with a Wall street twist?" Need I say more?
pss. Secret - Schwab makes 60% of its total revenue by simply sweeping cash nightly from customers' brokerage accounts into the firms' banking accounts.
"Humans make 95% of their decisions using mental shortcuts or rules of thumb - heuristics." - Daniel Kahneman.
** Thank you to the WSJ, Forbes and Fortune for their above quotes, statistics and advertisements.
** The above is not investment, tax or legal advice. Consult your advisors
** For more information on Jeff's Books, Blog, and Legal Challenge, please visit www.jeffmartinovich.com.
** To access JAM Views directly please visit jeffreyamartinovich.blogspot.com
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